Investors need to watch for a surge in poor governance practices by company boards and management under the veil of responding to the impact of COVID-19. The latest sustainability report of a major global manager, Dimensional Fund Advisors, warns of an increase in questionable corporate activity this year.
Dimensional managed US$527 billion ($A685 billion), as at September 2020, including about A$30 billion in Australia. The firm has a research-driven systematic style of investing which results in it owning more than 12,000 securities across all its equity and bond portfolios. Its strong ESG focus is therefore under-appreciated, as often is the case with other managers of very broad portfolios such as the big index managers.
The firm’s ‘Annual Stewardship Report 2020’ details its principles, processes and specific actions which are worth a read for insights on governance issues across the range for all investors. For instance, while Dimensional votes at a vast number of company meetings – 14,612 last year, covering 133,000 individual proposals – only 0.4 per cent of all proxy votes were about environmental and social shareholder proposals in that period. This is despite the strong “particular interest” Dimensional clients have in these votes, the report notes.
In fact, in terms of its direct engagement with companies, through a mix of letter-writing campaigns, calls and one-on-one meetings, environmental and social questions ranked number two, after executive compensation in total numbers. Board composition, shareholder rights and board structure were the third, fourth and fifth most frequent topics for engagement. The manager had discussions with 640 companies and initiated three letter campaigns targeting 500 companies last year.
With its Australian share portfolios, Dimensional voted against remuneration reports which included AMP, AP Eagers, AGL, Sigma Health and Sonic Healthcare. With board composition, the manager voted against the election of one or more directors at companies including AP Eagers, Brickworks, Crown and Freedom Foods. With disclosures, it voted against the adoption of the Paris carbon emission goals and targets for Woodside and Santos.
Notwithstanding its strong support for disclosures, so markets can include all information in prices, these are assessed on a case-by-case basis. Any costs are also weighed up against the benefits. For instance, if a certain level of additional disclosure in a particular area costs a lot of management time and company money, it may not be in shareholder interests. Dimensional tends to think like an owner – on behalf of clients, who are the owners.
From a governance perspective, Dimensional expects the impact of COVID-19 will be felt in the upcoming proxy season – ending June 30 in the US and other countries and from July 1 through to December in Australia, representing the first opportunity for investors to be informed by the crisis. “Additionally, shareholders will have had the opportunity to observe and assess management and board responses to the pandemic, which may raise important questions about compensation, board qualification and risk management,” the report says.
“Historically, times of extreme market volatility have been met with an uptick in hostile takeover bids and related shareholder activism. As companies face falling public valuations, management may be incentivised to adopt rights plans to head off perceived threats of a takeover, often citing their belief that current valuations do not reflect long-term intrinsic value,” it says. “Market prices are real-time and forward-looking, and therefore Dimensional believes that current valuations are fair estimates of value. We also believe that the market for corporate control, which can result in acquisitions at a premium to current valuations, is beneficial for shareholders and should be able to function without undue restrictions.”
While poison pills, used by management to make takeovers all-but impossible, are no longer common in Australia, the UK and Europe, they are still sometimes used in the US. Dimensional counted 49 companies which introduced poison pills, without shareholder approval, in the first half of last year.
In Australia, Dimensional has had a lot of meetings with companies about their capital raisings during COVID, which have resulted in a dilution of some shareholder positions, according to Bhanu Singh, Sydney-based head of portfolio management for APAC. “Dimensional [as a big institutional shareholder] generally receives its fair share in these transactions,” he says. “We think it’s an important topic to address and speak to companies about. If these transactions are not handled properly, as was the case in 2020, then it can lead to adverse outcomes for some shareholders.”
This topic has also been raised by special interest groups in the local industry, such as the SMSF Association, which has lobbied for an equal access to new corporate issues for smaller shareholders. Globally, Dimensional’s three main stewardship priorities for 2021 are:
. Executive compensation. The report says many companies have delayed finalising performance targets and metrics for the current period until markets ‘stabilise’. Dimensional expects some boards to reset executive performance metrics, reprice options or to use discretion to revisit decisions in response to fallout from the pandemic.
. Board effectiveness and assessment. In times of significant uncertainty, the importance of boards showing strong independent leadership is heightened. “It is critical that company boards are appropriately qualified to oversee risks to their company’s business. Dimensional will continue to focus on the importance of adequate board refreshment and assessment processes of portfolio companies, which are critical to maintain a qualified, effective board,” the report says.
. Disclosure. In keeping with its belief in the efficiency of markets, with prices reflecting all information as it becomes available, Dimensional is particularly concerned about the adequacy of corporate disclosures. COVID-19 has added to the risks due to working-from-home arrangements, supply chain uncertainties and rapidly changing public safety guidelines, the report says. “While uncertainty will undoubtedly continue throughout this crisis, effective governance demands that companies seek to address evolving risks while communicating those risks to shareholders.”
Dimensional has stronger active links to academia, probably, than any other major manager. The DFA operational company board includes co-founder and chairman David Booth, Nobel laureate Eugene Fama and his research partner Ken French, John ‘Mac’ MacQuown, and the two co-CEOs, David Butler and Gerard O’Reilly.
The mutual fund board, a US requirement which provides an oversight mechanism for investors rather than shareholders, has eight external academics. They include: Abbie Smith, George Constantinides, Douglas Diamond and John Gould from the University of Chicago; Ingrid Werner, a professor of finance from Ohio State University; Yale finance professor Roger Ibbotson; and, three professors from Stanford University – another Nobel laureate, Myron Scholes, and Darrell Duffie and Edward Lazear.
Greg Bright is publisher of Investor Strategy News (Australia)